Mexico's Game-Changing Energy Reform

What happened in Mexico last week represents one of the biggest global economic stories of the year. It may eventually be counted among the biggest stories of the decade.

By votes of 95 to 28 in the upper house and 353 to 134 in the lower house, the Mexican Congress passed a constitutional reform to allow private investment in the country’s oil and gas industries for the first time since those industries were nationalized in 1938. The measure received strong support from both the ruling Institutional Revolutionary Party (PRI) and the opposition National Action Party (PAN). As The Economist noted, it “went far beyond initial expectations” and was significantly “bolder” than the energy reform that President Enrique Peña Nieto first unveiled back in August.

Just a few years ago, when PAN leader Felipe Calderón was president, it would have been unthinkable for the PRI to endorse such a radical overhaul of the Mexican energy sector. Indeed, when in 2008 Calderón pushed to end the monopoly powers enjoyed by Pemex, the 75-year-old state-owned petroleum company, the PRI and the left-wing Party of the Democratic Revolution (PRD) insisted on watering down his reform until it became — in the words of Mexico-based petroleum geologist Colin Stabler — “only a slight improvement to the existing regulations.” In that sense, we should be grateful that the PAN has been more cooperative under Peña Nieto than the PRI was under Calderón.

Not surprisingly, the PRD fiercely opposed the 2013 reform, with one PRD lawmaker removing virtually all of his clothes during a speech in the chamber of deputies to protest the ways in which the bill would allegedly “strip” Mexicans of their rights and resource wealth. Despite some colorful and vociferous opposition, the reform sailed through both houses of Congress, and it has already been approved by a majority of Mexico’s 31 states.

Make no mistake: Peña Nieto’s historic energy law is a true game changer, both for Mexico and for international energy markets. Duncan Wood, director of the Woodrow Wilson Center’s Mexico Institute, has called it “the most significant change in Mexico’s economic policy in 100 years.” Former U.S. ambassador to Mexico Tony Garza has said that it represents “an extraordinary moment.” How extraordinary? Well, researchers at JPMorgan Chase estimate that the energy reform could increase annual foreign investment in Mexico by up to $15 billion while adding perhaps half a percentage point to the country’s potential growth rate. And the Wall Street Journal editorial page has predicted that, if the law is implemented correctly, “Mexico will begin to emerge as a global energy powerhouse.”

Until now, the Mexican oil and gas industries have been hampered by a dearth of investment and technology. Pemex deserves much of the blame. After enjoying a 75-year monopoly over the nation’s petroleum reserves, the company has become synonymous with waste, inefficiency and corruption. Brookings Institution fellow Diana Villiers Negroponte has observed that Pemex “only reinvests 15 percent of its total portfolio in exploration activities,” which is much less than the amount reinvested by Brazil’s Petrobras and other global energy giants. Thus, Mexico has lacked the money, equipment and skills necessary to access a major portion of its deepwater and shale reserves. As Citi analysts explained in a 2012 report: “Mexico has been frozen out of both the deepwater and shale revolutions, not because of a lack of potential, but because of a surfeit of self-imposed obstacles to getting capital, technology or human resources mobilized for discovery and exploitation.” If the new law unleashes a surge of private investment and drilling assistance from foreign multinationals, Mexico will finally have the cash, machinery and expertise to recover those reserves — and to reach its full potential as an energy producer.

Thanks to Peña Nieto’s reform, the Mexican government projects that daily oil production could increase from 2.5 million barrels today to 4 million barrels in 2025. Figures from Pemex indicate that Mexico’s total proven oil reserves stand at just over 10.1 billion barrels of oil equivalent (BOE), but they also suggest that more than three-fourths of total Mexican oil and gas reserves fall into the category of “prospective” (or unproven) reserves, including some 30 billion BOE worth of deepwater reserves in the Gulf of Mexico. Obviously, no one knows the exact number for sure; but if the Pemex estimates are relatively accurate, Mexico could indeed become a genuine heavyweight player in the global energy arena.

Does the reform pose any dangers to Mexico? Sure. A flood of foreign investment could conceivably lead to an overvalued peso, which would hurt Mexican exporters. Also, the Mexican government will have to reform its tax structure and become less dependent on Pemex revenue, which currently accounts for one-third to 40 percent of Mexico’s national budget. The underwhelming fiscal package that Mexican lawmakers passed in late October will modestly expand the tax base, but more ambitious, growth-oriented reforms are still needed.

By now, Mexicans are wearily familiar with false dawns and dashed expectations. When the North American Free Trade Agreement (NAFTA) took effect on January 1, 1994, they were promised that a wave of prosperity would follow. About a year later, however, the Mexican financial system collapsed. Similarly, when the PRI finally lost the presidency in 2000, ending 71 years of often authoritarian rule, Mexicans were told that democracy would help their nation achieve “first world” status. But then, in December 2001, China joined the World Trade Organization, and its subsequent emergence as a global export powerhouse did great damage to Mexican manufacturers, who found it very difficult to compete with their low-cost Chinese counterparts. More recently, right around the time that foreign journalists and investors began hailing Mexico as a potential “Aztec tiger,” the nation’s economy slowed dramatically.

So it’s understandable if Mexicans are a bit skeptical of all the enthusiasm surrounding their new energy law. After all, reforming the oil and gas industries won’t curb drug-related violence, end rampant corruption or fix Mexican labor markets. And yet, if Peña Nieto’s reform is properly implemented, Mexico may finally achieve the robust, sustainable economic growth that has for so long proven elusive. That would be worth celebrating.